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SARS’ Issue With ‘Connected Persons’… And Why This Matters To You

Thursday, 28 January 2010   (0 Comments)
Posted by: Author: Steven Jones
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SARS’ Issue With ‘Connected Persons’… And Why This Matters To You

For those of us who grew up in the South of Johannesburg, having"connections” was the key to survival. Whether you need your car fixed, a security gate welded, or even some decent boerewors for the Sunday braai, somebody always knew somebody who knew somebody who had a "connection” that could sort you out with whatever you needed—often for a very good price, if not the "right” price.

No doubt the drafters of the Income Tax Act did not live in the South, since they either did not know how our "economy” worked,or had an intimate knowledge thereof and were jealous that as "outsiders” they could not participate. Or—more likely—they were concerned that the use of these "connections” would result in the coffers of the State not receiving what they saw as its fair share of the transaction.

Their larney Northern Suburbs upbringing is reflected in the use, in Section 1 of the Income Tax Act, of the term "connected persons”.Granted, if you analyse the definition, it’s not quite the same as "connections” as we Southerners understood it, being defined as "a relative and any trust of which such natural person or such relative is a beneficiary” (natural persons).

For trusts a "connected person” is defined as "any beneficiary of such trust; and any connected person in relation to such beneficiary; in relation to a partner in a partnership a "connected person” is "any other member; and any connected person in relation to any member of such partnership.

In the case of companies, a "connected person” is "any person,other than a company as defined in Section 1 of the Companies Act,1973 (Act No 61 of 1973), who individually or jointly with any connected person in relation to  himself, holds, directly or indirectly, at least 20 percent of the company's equity share capital, or voting rights” whereas for close corporations (CCs) a "connected person” includes "any member; any relative of such member or any trust which is a connected person in relation to such member; and any other close corporation or company which is a connected person in relation to any member … or the relative or trust”.

To cut a long story short, a "connected person” is any person who stands to benefit from the actions of another who is connected through family relation, trust beneficiary, mutual partnership, or shareholding.

The problem that SARS would have is that transactions could be concluded between "connected persons” that are not on an arms-length basis, often bearing little resemblance to commercial liability. One example of how such manipulation could take place would be where someone who has been trading for their own account decides to start a company or CC,and then sell their business assets to the legal entity at grossly inflated prices so as to claim inflated wear and tear allowances.

Transfer pricing is another issue that often falls under SARS’ microscope when it comes to "connected persons”. Abuses usually occur whereby transactions take place between connected entities, one of which is located in a country that has a more favourable tax regime than South Africa.

In a typical scheme, goods will be sold at inflated prices by the foreign entity to the South African entity. This will enable the South African entity to claim a larger deduction, while the sales proceeds are taxed at more favourable rates in the foreign entity. Tax aside,connected entities also use such schemes as a means of taking money out of South Africa in contravention of Exchange Control regulations.

There are of course billions of rands of legitimate transactions that take place between "connected persons”, and the legislation does not seek to prohibit such transactions. It does however provide that such transactions need to take place at a market-related value on terms equivalent to an arms-length basis between a willing buyer and a willing seller.

Many SARS audits are around transactions between "connected persons”, and it is therefore sound business practice to have a formal transfer pricing policy in place.Where the transactions are large and complex, it may also be prudent to apply to SARS for an Advance Tax Ruling as well.

Source: By Steven Jones (Tax Breaks)



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